1. Counter corruption in your
supply chain in China
Secure your supply chain, and protect your reputation
Executive summary
The full report is available at www.ethicalcorp.com/china
Ethical Corporation
MARCH 2009

2. COUNTER CORRUPTION IN YOUR SUPPLY CHAIN IN CHINA
Contents
Foreword ..............................................................................................................................................................3
Executive summary..............................................................................................................................................4
Introduction ........................................................................................................................................................6
Section 1: Regulatory environment ................................................................................................................8
1.1 Relevant legislation ........................................................................................................................................8
1.1.1 Customs laws ........................................................................................................................................8
1.1.2 Laws on the Inspection of Commodity Imports and Exports................................................................9
1.1.3 Customs measures ................................................................................................................................9
1.1.4 Criminal Law ..........................................................................................................................................9
1.1.5 NPC’s supplementary provisions ..........................................................................................................9
1.1.6 Company law ........................................................................................................................................9
1.1.7 Addition to the Company Law ............................................................................................................10
1.1.8 NBCP ....................................................................................................................................................10
1.1.9 UNCAC ..................................................................................................................................................10
1.2 Multinational corporations and corruption mitigation..................................................................................10
Section 2: Chinese supplier relations ..........................................................................................................11
2.1 Official measures to counter corruption in the supply chain........................................................................11
2.2 Corporate measures ....................................................................................................................................12
Section 3: Case studies ..................................................................................................................................15
3.1 Corporate supply chain challenges and strategies ......................................................................................15
3.2 Case study 1: Japanese branded consumer-goods manufacturer ................................................................15
3.3 Case study 2: European mining company....................................................................................................16
3.4 Case study 3: Fortune 500 US IT company..................................................................................................16
Section 4: Concluding analysis ....................................................................................................................18
Appendices
Appendix A: Methodology ..................................................................................................................................19
Appendix B: References......................................................................................................................................19
Appendix C: Corporate questionnaire and responses ......................................................................................20
2

3. COUNTER CORRUPTION IN YOUR SUPPLY CHAIN IN CHINA
Foreword
f you are involved in compliance and affect the and revealing the most pertinent and most common
I ethical performance of your corporate operations
in China, than this is report is for you.
supply chain risks encountered. Our interviewees did
more than disclose their corruption risks; they have
Companies that effectively remove corruption risks shared their winning strategies for countering
om their operations understand that corruption can corruption in China.
occur at any point in a supply chain. Several compa- Proactive companies look beyond compliance and
nies have had to deal with supply chain corruption auditing.
very publicly. These include Fonterra (milk), Nestle Attentive companies implement internal anti-
(baby formula), DuPont (non-stick pans), Procter & corruption policies, detail risks in a CSR report,
Gamble (cosmetics), Johnson & Johnson (baby foods), monitor regulatory trends, make commissions and
Kra (GM ingredients), Lipton (tea), Smith Kline & fees transparent, introduce supplier ethics manage-
French (anti-inflammatory drugs), Colgate (toothpaste) ment (SEM) programmes and produce integrity due
and Haagen-Dazs (ice-cream). diligence reports on potential partner companies.
Ethical Corporation was interested in speaking We hope that you can incorporate some of these
with the major multinational companies in China lessons into your supply chain in China.
Ethical Corporation
Executive summary
he findings of this Ethical Corporation briefing trative Region (SAR) and Macao SAR; second, the
T underline the significance of China’s emergence
as the “world’s workshop” over the past three decades
Yangtze River Delta (YRD) extending om the munic-
ipality of Shanghai into Zhejiang and Jiangsu
since former leader Deng Xiaoping’s Opening Up and provinces and; third, the Beijing-Tianjin Corridor
Reform commenced. The findings also underline the (BTC) encompassing the region extending om the
importance of the country’s developing supply chain capital to Tianjin on the Bohai Gulf coast.
inastructure, an increasingly critical aspect of The Chinese government believes that the pace and
western multinational operations as the process of scale of this investment has been matched only by
expanding out om China’s tertiary cities – notably surging levels of foreign direct investment (FDI) – at
Beijing, Shanghai, Shenzhen and Guangzhou – and least until the second half of 2008. At this point FDI
into the country’s so-called tier inflows noticeably began to slow in line with the
two and three cities (ie those large cities in the onset of recession in North America and western
hinterland). Europe – as more multinational corporations estab-
Interviewees, all working for multinational corpo- lished mainland China businesses or developed and
rations with significant China-based operations, point expanded existing operations.
to the Chinese government’s massive investment in Multinational corporations (om the US and the
major construction and inastructure projects, EU but also, it should be noted, significantly om
primarily along the coastal regions where investment Taiwan, Hong Kong, Japan, South Korea and Singa-
has been concentrated. These key centres of invest- pore) have contributed to China’s manufacturing base,
ment can be defined as: first, the Pearl river delta which has subsequently grown rapidly on the back
(PRD) encompassing southern China’s Guangdong of cheap land, affordable, plentiful (and adequately
province bordering the Hong Kong Special Adminis- educated) labour and generally high levels of product
3

4. COUNTER CORRUPTION IN YOUR SUPPLY CHAIN IN CHINA
quality. These factors – together with the unfulfilled China’s exports were down 17.5% year-on-year in
potential of China’s domestic consumer market to January 2009, while imports fell by 43.1%, according
become the world’s largest – have further attracted to China’s ocial state statistician, the National
multinational corporations to source ever-increasing Bureau of Statistics (NBS). Tens of thousands of
volumes of products to the mainland to support a export-oriented companies in southern China –
growing domestic customer base, expanding foreign already under pressure before the onset of the global
retail operations and their own manufacturing financial crisis – have already been forced into
subsidiaries and aliates. bankruptcy by plummeting export demand, rising
As demand has increased, so Chinese manufac- labour, land, energy and commodity costs and the
turers have modernised production, kept labour costs tougher enforcement of environmental and labour
down (though it should be noted that wage rates laws following the introduction of China’s signifi-
began to rise more sharply in 2008) and so beaten the cantly more stringent labour laws in 2008.1 As
global competition through a combination of low economic pressures on local suppliers and other
costs and high quality. external partners increase, some executives believe
However, the pace and scale of this growth has that the tendency to resort to corruption – be it in
inevitably raised substantial and varied opportunities securing deals, maintaining relationships or just
for corruption within the supply chain, while China’s topping up levels of personal income – has the poten-
inexperience of ethical and anti-corruption compli- tial to increase in the current period of uncertainty.
ance regulations make the task even more dicult to Against this backdrop of economic recession,
tackle. For more details on ethical and anti-corrup- increased pressure on both exporters and importers and
tion compliance see ECI’s report Anti-Corruption, credit crunch this briefing yields three key findings.
Ethics and Compliance in China – February 2009. First, the problems of corruption facing China’s
Corruption – be it bribery, kickbacks, product supply chain – and its overall business environment –
substitution, misappropriation, aud and/or other will not disappear overnight, despite tremendous efforts
financial crimes – clearly remains a challenge for by the authorities om Beijing down to provincial level
multinational corporations and their local Chinese to crack down on iningers and to create a robust
joint-venture ( JV) partners alike. regulatory environment.
Interviewees for this briefing unanimously believe Second, such is the size of China and the relative
that the arrival of the global economic downturn is concentration of foreign investment and economic
forcing multinational corporations in developed development in certain key regions that corruption
countries to revise their global strategies, with the issues relating to the supply chain and general
impact being felt in developing markets where goods business standards vary substantially. Those coastal
and materials are equently sourced and the supply regions that benefited first and for longest om
chain based. In the current international economic inflows of FDI, for example, tend to have far higher
climate all supply chains are increasingly vulnerable standards of integrity and transparency than inland
to risk, though China remains somewhat insulated and more remote provinces which have less experi-
om the worst effects of the worldwide recession. ence of economic reform and foreign investment.
Yet, despite this, the crisis has undermined some Third, it has emerged om ECI research that one
of the basic precepts required for ethical and legal of the best ways to mitigate corruption-related risk
outsourcing. Many companies are finding that they in the supply chain is to set up and maintain effective
must now quickly mitigate the possible increase in in-house programmes which actively implement
corruption and other risks as the impact of global compliance codes and evaluate supply chain partners
trade disruption becomes more acute. China itself is based on ethical and compliance criteria.
somewhat at risk om weakening export growth –
1 For more on this subject see Harney, Alexandra (2008) The China Price: The True Cost of Chinese Competitive Advantage (Penguin).
4

5. COUNTER CORRUPTION IN YOUR SUPPLY CHAIN IN CHINA
Introduction
hina’s emergence over the past three decades as national investors is considerable. Corruption in
C the world’s chief manufacturer and sourcing base
for multinational corporations is virtually unprece-
China has a long history. Local business culture is
traditionally based on relationships and oen involves
dented. The pace and scale of this growth om such running businesses in partnership with family or
a low base and with few established regulations has iends – making related-party transactions, so
created an economic environment where corruption lending and non-contractual agreements the norm
and bribery have been able to flourish, particularly rather than the exception. This tradition, together
given China’s opaque operating environment, weak with the endemic bribery and gi-giving which are
legal enforcement record and its reliance on relation- still a major part of relationship-based business in
ships (known as guanxi) in commercial transactions. China, despite government attempts to limit the
Despite the operational challenges, China’s practices, increases the challenges for multinational
growing prominence as a global sourcing centre has corporations tasked with meeting global compliance
prompted multinational corporations continuously to standards.
redesign their sourcing and manufacturing systems From an operational perspective, for many multi-
on the mainland, thereby creating some of the most national corporations, corruption in China is
effective and cost-ecient supply chain systems in perceived to be part of the cost of doing business on
existence – and increasing multinational corpora- the mainland. The trends identified in the World
tions’ dependence on the China component of their Bank and International Finance Corporate Enterprise
business. US technology giant IBM even opened its Surveys 2003 (albeit a five-year-old document) still
first supply chain innovation centre in Beijing in hold true: 73% of the companies surveyed reported
March 2008. The centre’s remit is to integrate and that they expected to pay “facilitation payments” to
transform the company’s global supply chain capabil- get things done – a clear illustration of the extent of
ities.1 Despite the appearance of so-called “China + 1” corruption. According to the same survey, the sectors
policies of diversification of production and sourcing most affected by corruption were construction, finan-
to other developing economies China retains the cial services and public sector procurement.
lion’s share of orders and FDI.
With so many supply chain operations moving to
China, the need for effective controls has increased On the Logistics Perception Index, China ranks
both on the part of the central government and the an impressive eighth, behind (amongst others)
multinational corporations themselves – particularly Singapore, the Netherlands, Germany, Sweden,
in the wake of food safety and product quality Australia and Japan. It is noticeable that China
concerns which have become more equent over the beats Taiwan, Canada, Australia and the US.
past two years.2 Yet supply chain issues extend into
numerous areas: labour practices; local quality control
and inspection; shipping eight costs; environmental Yet China appears to be getting at least something
issues; intellectual property (IP) and copyright issues; right when it comes to the supply chain environment.
and, crucially, supply chain security. The WB’s Logistics Perception Index (LPI) provides an
These supply chain operations are increasingly the indication of logistical eciency amongst different
focus of multinational corporations. China’s logistics countries around the world. First released in 2007, the
industry enjoyed 26.2% year-on-year growth to LPI is based on seven key factors: 1) eciency and
$10.7tn in 2007 alone, according to the China Feder- effectiveness of the clearance process by customs,
ation of Logistics and Purchasing (CFLP).3 Amidst this excise and other border control agencies; 2) quality of
rapid double digit growth are to be found increasing transport and information technology inastructure
opportunities for massive financial gain by underpaid for logistics; 3) ease and affordability of arranging
local government ocials, entrepreneurs eager to shipments; 4) competence in the local logistics
amass personal fortunes as quickly as possible as well industry (transport operators, customs brokers, etc);
as regular employees seeking to “top up” their 5) ability to track and trace shipments; 6) domestic
salaries. At the same time, multinational corporations logistics costs (local transportation, terminal handling,
are aware of a global trend towards regulatory warehousing, etc); and vii) timeliness of shipments in
compliance that increasingly encourages ethical terms of reaching their final destination.
business and global governance standards. On this seven-point scale, China ranks an impres-
The challenge that corruption presents to multi- sive eighth, behind (amongst others) Singapore, the
5

6. COUNTER CORRUPTION IN YOUR SUPPLY CHAIN IN CHINA
Netherlands and Japan. It is noticeable that China Afghanistan, Pakistan, Burma, Bhutan and Nepal).
beats Taiwan, Canada, Australia and the US.4 In a Furthermore, China’s border regions tend to be
sense this is not surprising as China has grown occupied by ethnic minority groups which oen have
partially through becoming a major exporter and so more in common with the neighbouring country
therefore has needed to be ecient in terms of trans- than with China itself: Xinjiang’s Muslim ethical
portation and shipment to achieve this. Nevertheless minority Uighurs (who identi with their Islamic
it is a tribute to the advance of the last three decades. neighbours to the west and south); Mongolians;
Within logistics and supply chain eciency, Tibetans; and a large number of smaller ethnic
customs issues and border controls figure promi- minorities that populate the more remote parts of
nently. China’s 15 close neighbours range om some southwest China’s borders with Burma, Thailand,
of the world’s largest countries (such as Russia and Laos and Vietnam. Inevitably, in the country’s more
India) and historically its greatest enemies (Vietnam) remote regions away om the transparent, invest-
to smaller central Asian republics (Kazakhstan, ment-iendly coastal regions and large cities,
Kyrgyzstan, Tajikistan) and countries with troubled the problem of ocial corruption figures more
political and/or security environments (North Korea, prominently.
1 China Economic Review, IBM Launches Supply Chain Innovation Center, March 27 2008.
2 Though the 2008 Sanlu tainted milk scandal (where milk was tainted with melamine) made front page news globally a range of
food safety and product quality concerns have hit the headlines in China and overseas in just about every sector from toys to
toothpaste and pet food to yoghurt.
3 See China Economic Review, China’s Revenues from Supply Chain Business Soars 26%, April 3 2008.
4 See China Economic Review, China is Very Logistically Efficient, January 25 2008.
6

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